EARLIER this month, the FTSE 100, German Dax and major US stock indices were trading at multi-year highs. They all hit levels last seen when the financial crisis took hold in early 2008. But these indices have struggled over the past few weeks, pulling back around 3 to 5 per cent. This could be a healthy correction which will blow any speculative froth off stocks. If so, then once the market finds support, we can expect a period of consolidation, which will form the foundations for another move higher.
Yet this pull-back could be an indication of something more serious. Investors are finding it increasingly difficult to ignore the chronic debt issues across the developed world, while concern about rampant inflation in developing countries is leading to monetary tightening and slower global growth.
Investors have been pricing in the end of America’s second round of quantitative easing (QE2) next month, selling riskier assets ahead of the loss of a vital source of liquidity. Yet there has been a marked softening in economic data recently, which has led to speculation that the Federal Reserve will quickly implement a fresh stimulus programme to replace QE2. In the US, last week’s GDP revision, jobless claims and durable goods all disappointed, while we have seen deterioration in PMI readings from the US, Europe, China and the UK. We’ll see an update on US and UK PMIs this week, and get an update on US unemployment with non-farm payrolls on Friday.
Although equities will get a lift on talk of further QE, the political obstacles to its implementation are substantial. After all, another stimulus programme is in effect an admission that all previous efforts have failed. In the meantime, the upside momentum that has been a feature of global stock indices since last August is now fading. This is particularly noticeable in the Russell 2,000, an index made up of 2,000 smaller US companies with an average market capitalisation of $1.25bn. Earlier this month, it hit a record all-time nominal high, yet now looks like breaking below its long-term uptrend.
So that tired old aphorism that begins “sell in May and go away” is getting its annual airing. This year, it could be warranted, as investors struggle to justify taking on additional equity exposure, and traders are happier selling rallies than buying dips.